2. Your firm uses the audit risk model, AR = RMM * DR, in its decision support computer software for planning tests of accounting cycles.

The firm's calculates DR based on AR and RMM.

RMM is your assessment of the risk of material misstatment that is based on the OPERATING effectiveness of controls

That is, you have tested the controlS AND you have made an assesment of how well they function.

The firm's software asks you to specify the operating effectiveness in terms of one of the following: WEAK, MODERATE or STRONG

Part A:

Suppose, for example, that MODERATE implies that 15% <= RMM < 30%. This is a judgment call.

If you enter MODERATE when you are planning to test the operating effectiveness of controls, the software calculates DR assuming that RMMp = 15%, instead of 30%.

Briefly, explain why the firm's policy setters would choose 15%, instead of 30% as RMM for calculating DR.

Part B:

If RMM = 15% and AR = 5%, what would planned DR be?

Part C:

The literature states that the audit is dynamic and can be revised as the audit progresses

Suppose that the auditors's tests of controls [to determine operating effectiveness] reveal that RMM = 5%

What does this imply for the DR calculated in 2B above answer for the extent of substantive testing?